Macquarie raised ideas about the damage to Brazil's cane
crop from dry weather, but cautioned over the rally in prices, even as futures
hit a two-month high – albeit still underperforming coffee, which soared a
further 4%.

The bank said that, because of hot and dry weather, the cane
harvest in Brazil's Centre South region, responsible for some 90% of domestic
output, will come in at 585m tonnes in 2014-15, down 10m tonnes year on year on
its own estimates.

"Extremely low" rainfall in the Centre South from December
to February "has led to serious concerns that the new season's cane crop may
see some yield losses", Macquarie analyst Kona Haque said.

"Cane development has slowed, and there are reports that
some new cane planted last year has shrivelled up in the heat and lack of
moisture, rather than maturing."

'A little too
sceptical'

The forecast undershoots an estimate from the Unica cane
industry group on Monday that cane output for the season, starting in April,
will no longer exceed the 2013-14 result of 596m tonnes.

And it came as fears for the dryness continued to support prices
of sugar, which hit 16.80 cents a pound on Wednesday for New York's best-traded
May futures, a two month high for a nearest-but-one contract.

Arabica coffee futures - which have reacted even more
strongly to the dryness concerns, given the prospect of far bigger damage to Brazil's
output – hit 161.85 cents a pound in New York for May delivery, a 15-month
high.

While central Brazil had received some rain over the
weekend, "the growing areas for coffee and cane need consistent rain to
permeate through hard dry soil otherwise it just runs off", Nick Penney at Sucden
Financial said.

"Perhaps we sugar traders have been a little too sceptical
on what is happening in Centre South Brazil."

'Send the wrong
signals'

However, Ms Haque cautioned that, unless damage to Brazilian
cane production proves particularly severe, the sugar market may be storing up
trouble for itself by sending futures soaring, in working against the process
of eroding the sugar surplus needed to foster a longer-term price recovery.

World sugar output has exceeded demand by an aggregate 27.0m
tonnes over the four seasons to 2013-14, which global stocks will end at 65.2m
tonnes, according to the bank.

"In the 3-6 month period, the flat price needs to fall lower
to 14 cents a pound, or that calendar spreads widen, to encourage more storing
by producers," Ms Haque said, warning that higher values would "send the wrong
signals to the market".

A price above 16 cents a pound "would incentivise more
Indian raw sugar to be exported, a greater allocation to sugar vs ethanol by
Brazilian mills, more forward selling of raw sugar by Thais, and deter Chinese
imports".

'Premature price
rally'

"Any or all" of these factors would "merely keep the world
sugar surplus higher for longer, leading to further price pressure down the
line", Ms Haque cautioned.

"Given the largest surplus we still need to work off… a premature
price rally would be immature."

Low sugar prices had been working to quell the output
surplus, in appearing to leave few producers with a chance of profit.

The bank estimated production costs in Asia Pacific, Australia
and South Africa at 16 cents a pound or more; in Thailand and Central America
at at least 18 cents a pound; in Brazil at 17-19 cents a pound; and in the
European Union and India at 20-22 cents a pound.

Price moves

Raw sugar for May stood at 14.72 cents a pound in New York
as of 09:00 local time (14:00 UK time), up 1.3%, with London white sugar for
May up 0.7% at $459.00 a tonne.

New York arabica coffee for May was 2.9% higher at 159.30
cents a pound, with London robusta beans for May up 1.8% at $1,908 a tonne.